Mike Hogg, managing director of DONG Energy UK, gives his perspective on how natural gas prices in the UK can be expected to develop over the next two years.
Predicting the future pricing of any commodity has its challenges but natural gas is especially difficult. As a product traded in a global market, its value at any point in the calendar is determined by a kaleidoscope of factors.
On top of the usual market dynamics of supply and demand, the weather creates volatility on a daily basis for traders. The Energy Industry Association has said that colder winter temperatures forecast for 2013 and 2014 (compared with the record-warm temperatures in 2012) are expected to increase the amount of natural gas used for residential and commercial space heating.
While the broad pattern is predictable – cold temperatures push up demand – the severity or otherwise of a winter is not, and it’s no surprise that a therm of gas can be traded 15 or 20 times before it’s delivered.
Storage capacity is another short term dynamic. In a competitive commodity environment where the demand is highly variable, storage becomes critical in balancing demand and supply conditions. In general, that means buying and storing during the summer months, when demand and therefore prices are lower, helping to offset the higher costs that come with the additional pressure on supplies in winter.
Given the persistence of the economic downturn in Europe it’s no surprise that the demand for commercial and industrial gas has dipped of late. Indeed both Ofgem and the Committee for Climate Change reported recently that this dip has been the main reason we are reaching our carbon targets.
When the economy is booming, output from the industrial sectors generally increases, with an accompanying rise in need for energy. When the economy is in recession, industrial output drops.
Over the last 12 months demand for natural gas in Europe has declined by about 3.6% – a reflection of the debt, funding and business confidence issues that have played out so strongly within parts of the EU.
But falling demand is not all about the downturn. Efficiency measures such as the introduction of Automated Meter Reading (AMR) technology have provided commercial users everywhere with much sharper insight into consumption through access to accurate and timely meter reading data. This data helps customers analyse and track gas consumption and therefore improve efficiencies, with savings of up to 20% in some cases. At the same time, the greater effort placed on reducing CO2 emissions continues to have an impact.
As a gas supplier, we know the value of improving our customers’ understanding of their patterns of consumption – after all, monitoring energy use is the first step towards managing it. The impact of AMR on energy management can certainly be profound. By giving manufacturers a much deeper appreciation of the base-load and volatility of their gas consumption, AMR allows them to work with their supplier in an informed way to select the most appropriate contract. This minimises the risk of consuming too much or too little gas and the resultant costs and penalties that can arise.
Contractual variations
Given the wide spectrum of sectors that our UK customers operate in, it’s difficult to generalise how contractual preferences have been influenced by the tougher economic climate. That said, the majority of SME business is now typically done on one or two year fixed priced contracts, with customers often taking advice from energy consultants about procurement.
At the larger end, with major industrial or manufacturing users, there is more focus on flexibility. Customers want maximum optionality, to fit their buying strategy to the market, for example, allowing them to buy tranches at the most cost-effective time, or selling back if that meets their needs.
At the same time, contract lengths can still be variable, with typical contract durations of one to three years although some buyers are looking at even longer terms to really cement a partnership based on mutual trust and understanding. Margins continue to be extremely tight across the board so we compete on the basis of the quality of our service and account management.
Whatever the size of the business, a big part of any relationship is about being ready, willing and able to facilitate easy access to information about consumption and increasing a customer’s knowledge of how the market works and what’s going on. Having a more detailed understanding helps improve their purchasing strategy.
In the short and medium term the development of liquid hubs in Europe is likely to see a bunching of the different hub prices we have currently. So we expect to see a moving together of the different prices for gas in Europe. This will be more marked in Northern Europe, where it is now virtually impossible to sell industrial/commercial customers gas on the basis of fuel-oil or gas-oil indexation, which was the norm only a few years ago.
Some of the southern European markets are still linked to Brent Crude Oil pricing but as their markets start to develop liquid hubs there will be a move towards a single traded price. This development is very interesting because it then begins to frame Europe as a single market for gas and for the cargoes of liquefied natural gas (LNG) from North America, Australia and Angola in the medium term future.
Shale gas – a game changer for the UK too?
There’s no doubt that the arrival of unconventional gas – primarily shale gas or coal bed methane gas – has been a game changer around the globe, no more so than in the US. The combination of traditional natural gas and these unconventional sources means we now have some 250 years’ of known supply at current projected levels of demand.
It has become a significant reality in North America, where the US was an importer in gas but now has an over-abundance of supply. US prices have dropped down to about 15p per therm and there has already been a dramatic impact on global prices as there’s no longer US demand LNG imports. In the UK, shale gas is still a contentious issue with conflicting messages about the pros and cons coming from the government, communities and interested parties on a daily basis.
One major issue in the UK is that our greater population density than in, say, the US means there are significant planning regulations to consider when proposing to extract the gas. However there is substantial government support for shale gas to eventually be developed here and elsewhere in Europe, as all energy sources will be considered in an attempt to prevent the lights going out.
Longer term, the most powerful trend in energy is simply population growth. Energy demand is going to double between now and 2050 as we move from the current population figure of some 7 billion people to 9 billion by 2050. Most of that growth is going to happen in countries with relatively low GDP. In the past there has been a perfect correlation where, for every 1 per cent growth in GDP, we saw a half a per capita increase in energy intensity. But in places like India, China and Malaysia, the correlation is actually one-to-one or greater.
Meeting the energy challenge
If you picked any one of the conventional sources of energy you will certainly see channels and how they might struggle to keep pace.
For example, if you saw coal as a way of meeting this demand: consider that the current average wait for a ship outside the Australian coaling port of Newcastle is two to three weeks. So even if you can find coal, actually moving it to where it’s required is a huge logistical challenge.
If we take nuclear, particularly in the wake of Fukushima, there are increasing technical challenges and associated political and planning concerns. As far as oil goes, half of what we need to find between now and 2015 is to replace those sources which we know already will be depleted over that same time period. Theirs is also focus on renewables – and this should form an important part of the energy mix however, gas needs to be there to fill the gaps as part of a dual fuel solution.
Gas is both accessible and abundant. The UK happens to be well-connected in terms of natural gas supply. We have the Langeled pipeline running from Ormen Lange field in the Norwegian Sea to Easington on the English east coast – the world’s longest underwater gas pipeline. We also have the interconnector pipeline crossing the North Sea between Bacton Gas Terminal in Norfolk and Zeebrugge, Belgium. Europe itself is within reach of about 70% of the world’s known supplies of gas thanks to a complete and extensive pipeline infrastructure. Indeed, the UK import infrastructure that we have now is double what we need.
The global picture will always be a complex mix of demand and supply and energy trends are notoriously hard to predict with differencing policies in different countries. Companies can migrate some of their risks by making energy management a strategic priority for their boardroom and monitoring energy usage through automated meters readers and customer portals. This minimises the risk of consuming too much or too little gas and therefore the cost implications.